As concerns continue regarding the possibility of an economic downturn, plan sponsors should be aware of the effects that two potential downturn events could have on their qualified plans.
Substantial Cessation of Operations (Section 4062(e) Event)
Where there is a substantial cessation of operations at a facility, an employer maintaining a qualified defined benefit plan may be subject to certain notice requirements and termination liability rules. A substantial cessation of operations occurs when a permanent cessation of operations at a facility results in the loss of employment by employees at the facility who constitute more than 15% of all employees who are eligible under the plan.
An employer maintaining a single employer plan that experiences a substantial cessation of operations is subject to the withdrawal liability and notice rules that otherwise apply to an employer contributing to a multiemployer plan. Thus, the employer must notify the PBGC of the “withdrawal” within 60 days after its occurrence, and must request that the PBGC determine its liability with respect to the withdrawal. As soon as possible after this request, the PBGC will determine if the employer is liable for any amount relating to the withdrawal.
A partial termination occurs when the IRS so determines, based on all the facts and circumstances. The IRS determines one type of partial termination, a “vertical partial termination,” by looking at a plan sponsor’s turnover rate. This rate equals the number of employees participating in a defined benefit plan who had an employer-initiated severance from employment during the applicable period, divided by the sum of all participating employees at the beginning of the applicable period plus all employees who became participants during the applicable period. Though there is no set rule on what turnover rate would automatically result in a partial termination, the IRS has ruled that where the turnover rate is at least 20%, there is a rebuttable presumption that a partial termination has occurred.
The other type of partial termination, a “horizontal partial termination,” may occur in a defined benefit plan when benefit accrual decreases or ceases, in turn creating or increasing the possibility of a reversion to the employer or employers maintaining the plan. A plan that experiences a partial termination must, to the extent the plan is funded, fully vest all participants affected by the partial termination.
In addition, a number of other events that may occur in a downturn could obligate employers maintaining defined benefit plans to notify the PBGC; most obviously, a reduction in the number of active participants in the plan (which could occur in the case of a mass layoff or an early retirement incentive program), or the liquidation or insolvency of any member of the plan sponsor’s controlled group.
If you have any questions or would like more information about the potential impact of an economic downturn on qualified retirement plans, please contact the authors or your Morgan Lewis contacts.